A separation property is a crucial element of
modern portfolio theory
Modern portfolio theory (MPT), or mean-variance analysis, is a mathematical framework for assembling a portfolio of assets such that the expected return is maximized for a given level of risk. It is a formalization and extension of diversificatio ...
that gives a
portfolio
Portfolio may refer to:
Objects
* Portfolio (briefcase), a type of briefcase
Collections
* Portfolio (finance), a collection of assets held by an institution or a private individual
* Artist's portfolio, a sample of an artist's work or a ...
manager the ability to separate the process of satisfying investing clients' assets into two separate parts.
[Bodie, Z, Kane, A, and Marcus, A, (1999), ''Investments'' 4th Edition, ]McGraw Hill
McGraw Hill is an American educational publishing company and one of the "big three" educational publishers that publishes educational content, software, and services for pre-K through postgraduate education. The company also publishes referenc ...
, , pp 226–7
The first part is the determination of the "optimum risky portfolio". This portfolio is the same for all clients. In one version, it has the highest
Sharpe ratio
In finance, the Sharpe ratio (also known as the Sharpe index, the Sharpe measure, and the reward-to-variability ratio) measures the performance of an investment such as a security or portfolio compared to a risk-free asset, after adjusting for its ...
. See
mutual fund separation theorem In portfolio theory, a mutual fund separation theorem, mutual fund theorem, or separation theorem is a theorem stating that, under certain conditions, any investor's optimal portfolio can be constructed by holding each of certain mutual funds in app ...
for a discussion of other possibilities. It is the construction of a
universal portfolio that is kept separate from the individual needs of each client.
The second part is tailoring the use of that portfolio to the risk-aversive needs of each individual client. This is achieved through simulation of a given
risk-return range by allocating the client's total investments partly to that universal portfolio and partly to the risk-free asset.
See also
*
Markowitz model #Choosing the best portfolio - an expansion of the above
*
Mutual fund separation theorem In portfolio theory, a mutual fund separation theorem, mutual fund theorem, or separation theorem is a theorem stating that, under certain conditions, any investor's optimal portfolio can be constructed by holding each of certain mutual funds in app ...
- relating to the construction of
optimal portfolios
*
Fisher separation theorem
In economics, the Fisher separation theorem asserts that the primary objective of a corporation will be the maximization of its present value, regardless of the preferences of its shareholders. The theorem therefore separates management's "product ...
- discussing an analogous result in
corporate finance
Corporate finance is the area of finance that deals with the sources of funding, the capital structure of corporations, the actions that managers take to increase the Value investing, value of the firm to the shareholders, and the tools and anal ...
References
Finance theories
Mathematical finance
category:Financial economics
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